I am reading a Tax Court case.
I disagree with commentary on the case.
Let’s talk about Michael Smith and his 2022 tax return.
Michael worked a couple of jobs in 2022 and reported wages of $16 grand on his individual tax return. I see that one of his employers was New York City Transit. Michael would not have gotten far in New York with only $16 grand of earnings.
He applied for Social Security disability in April 2022.
I am thinking that he worked, got injured and applied for disability.
In November 2022, the SSA sent a letter saying that he qualified for SSI retroactive to March. He received SSI of $26,802 for the year.
And in April 2023 the SSA wanted the money back.
Why?
The SSA explained:
Your disability payments were stopped as of April 2023 because we learned that you had been working since April 2022.”
Well, so much for my guess that he got injured and stopped working.
Michael repaid what he could and set up a payment plan for the balance.
What makes this a tax case is that Michael left the SSI off his 2022 tax return.
Social security disability is taxed the same as regular social security. There is an unfortunate tax maze here, I admit. Up to a certain income, 50% of one’s social security is taxable. Keep increasing income and up to 85% is taxable. Land someone in-between and you almost need software to do the math. It is not a pretty area of the tax Code, frankly.
Michael explained that he omitted the social security because it was “an accidental overpayment” and was “repaid … in full.” He considered it more a loan than taxable income.
I get it, but Michael ran face first into a basic principle in taxation: you have to report what happened during the taxable period. In this case the period was 2022. By the end of 2022 he did not know that he would be required to return the money to the SSA. This was income free-and-clear when the New Year’s ball dropped.
OK, you ask: when would Michael make it right on his taxes?
In 2023, when he found out and returned the money.
How would Michael make it right?
He would do a special calculation on his 2023 return.
The concept here is called “claim of right,” and it goes back to a famous 1932 tax case. It was formalized into the tax Code in 1954 as Section 1341.
Have you ever read or heard a case about a corporate executive or professional athlete having to return money to his/her employer or team? The tax side (almost certainly) involves Section 1341.
How does it work?
First, there have to be (at least) two tax periods at play. If Michael had learned and repaid the SSA by the end of 2022 there would be no tax issue. It is flipping the calendar and starting another period that sets up the claim of right.
Second, there are two calculations, and you use the one yielding the smaller tax.
You run the tax for the year (of repayment) with the deduction, and
You (re)run the tax for the original year (that is, the claim of right year) with the deduction.
You use the smaller tax.
And yes, there can be trap here.
What if the repayment year has much less (or worse, no) income than the claim of right year?
You have a problem because the calculation takes the smaller of the two amounts. The flaw is baked into Section 1341.
The commentary I read speculated that the case may have involved a statute of limitations issue.
Nope, methinks.
Our secret mystery obscure Section 1341 kicks-in for the repayment year, which is 2023 in this case. The 2023 return was due on April 15, 2024. Let’s skip extensions and whatnot: the earliest that statute will expire is April 15, 2027.
No, I don’t think that was it.
Michael went for a long shot and hoped to exclude the income from his 2022 rather than 2023. Why?
Because Michael had no (or little) income in 2023 to absorb the Section 1341 lesser-of calculation.
I am again wondering if Michael was truly disabled in 2022 and subsequently got run over by both the SSA and IRS.
Our case this time was Smith v Commissioner, T.C. Memo 2026-25.
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